YEAR-END TAX PLANNING TIPS

By Rev. James R. Cook, CFP^®, RICP^®

We are now in the fourth quarter of the year, which means it is the perfect time to consider tax planning. 

Many of us only think of our taxes when we sit down to pull information together to complete our tax returns, but by then it is often too late to make changes that could potentially save on our taxes, or at least make preparing our taxes easier.  

Reducing taxable income

The primary way that you reduce the amount of taxes you pay is by reducing the amount of income that is considered to be taxable. This does not have to mean making less money; rather, it usually means putting money into tax-advantaged accounts or maximizing the use of money that can be received tax-free. Let’s review some ways to reduce your taxable income.

Retirement savings accounts. This can be traditional IRAs or workplace 403(b) or 401(k) accounts. Every dollar invested in one of these accounts reduces your taxable income, potentially saving you on your federal taxes, as well as your state taxes if you live in a state that has an income tax. The additional long-term benefit is that you are also building assets for the future.

“As you come to the end of the year, it is a good time to review your housing expenses to date and project where you will be at the end of the year. If you think you will have excess funds, consider ways to use them for eligible expenses; otherwise, any leftover funds will be treated as excess housing allowance and subject to taxes.”

529 plans. These plans offer a tax-advantaged way to save for a child or grandchild’s college education. They won’t reduce your income for current federal taxes, but when the benefits are withdrawn and used for qualified educational expenses in the future, the money comes out tax free, including the earnings. If you live in a state with a state income tax, you might be able to reduce your current-year taxes if you participate in a plan sponsored by your own state.

Housing allowance. Most ministers take advantage of the ability to claim some of their ministry income as tax-free housing allowance. Remember that your employer must set the amount of the housing allowance in advance of paying it to you (normally done at the beginning of the year). You must track your actual expenses for the year, and you are then allowed to claim as housing allowance on your taxes the lesser of:

• The amount declared to you by your employer

• The actual amount you spent

• The fair rental value of the property furnished, plus utilities

As you come to the end of the year, it is a good time to review your housing expenses to date and project where you will be at the end of the year. If you think you will have excess funds, consider ways to use them for eligible expenses; otherwise, any leftover funds will be treated as excess housing allowance and subject to taxes. Use your current expenses and any changes you anticipate in the coming year to revise your 2022 housing allowance declaration with your employer.

Qualified charitable distributions. If you have funds in an IRA and are age 70 1/2 or older and intend to make gifts to qualifying charities, consider making a Qualified Charitable Distribution (QCD) from your IRA. Charitable distributions made as QCDs are different than donating and then claiming a deduction. QCDs immediately reduce your taxable income because they are taken from a taxable account but not reported as income and thus not subject to limits on charitable deductions.  

If you are subject to Required Minimum Distributions (currently individuals aged 72 and older), any amount taken as a QCD counts toward your Required Minimum Distribution. Note that QCDs may only be taken from traditional IRAs; they may not be taken from Roth IRAs or 401(k) or 403(b) accounts.

Other items to review

FSA accounts. If you have a flexible spending account for healthcare or childcare expenses, check your balance and plan to use it before year-end. This is money that you or your employer have contributed to the account that you can receive tax-free. While some accounts let you roll some unused portion over to use the following tax year, not all do. You will lose any amount you ultimately end up not spending.

Estimated taxes and withholding. When you do complete your 2021 taxes, pay attention to the amount you either owe for taxes or the refund that you receive. If either number is large, consider modifying your W-4 Withholding Certificate or the amount you pay in Quarterly Estimated Tax payments to reduce the discrepancy between your actual taxes and the amounts you have had withheld or paid.

Final thoughts

As the year ends, it is a good time to make sure that your records are in order so that doing your taxes next year will be easy. Create a 2021 tax file and start collecting information as it comes in. You will thank yourself when you sit down to prepare your taxes, or hand off information to your tax preparer, and don’t have to go hunting for a misplaced form.

Rev. James R. Cook, CFP^®, RICP^® is a Financial Planning Specialist. He brings expertise in comprehensive financial and retirement planning to his work at MMBB. Cook holds a B.S. in Psychology from Lewis & Clark College, a Master of Divinity degree from Fuller Theological Seminary, and an MBA from the University of Missouri Kansas City.